1

A brief discussion on the similarities and differences in delivering a pension

benefit through insurance or a pension fund (or other occupational vehicle)

Further to earlier discussion in IAA committees, this paper considers in high level terms
similarities and differences between life insurance and pensions. It is written in generic terms
informed by legislation and practice across a range of countries1.

A. Preliminary
Through (or in connection with) the employment contract2, an employer makes a promise to
pay an employee deferred pay (the ‘benefit’ - typically in the form of a lump sum or annuity)
in the future in return for services carried out now from the employee. The terms of the
employee’s employment contract dictate the nature of the promise, including formalising part
or all of it as a contractual commitment under local law, which typically is subject to
uncertain risks (longevity, early retirement, price inflation, pay inflation etc). Social and
labour law may place conditions around the promise (e.g. the concept of accrued rights, or
mandatory indexation etc).

The nature of the employment contract, and therefore the nature of the promise the employer
is making, varies with local law. Elements of the promise may be guaranteed in nature, others
may depend on the discretion/goodwill and financial success of the employer.

Depending on local law and market development, an employer may have a number of
mechanisms (individually or in combination) to fulfil its commitment/promise to pay the
pension e.g,
a. out of revenue on a pay as you go basis (with or without a book reserve under local
GAAP, or backed by interest in specific assets on the employer’s balance sheet)
b. using a pension fund or similar financing vehicle
c. by taking out a policy with an insurer as an asset of the employer (or an asset of the
pension fund which the employer sponsors)
or
d. by paying premiums to an insurer who takes on legal and economic risk from the
employer to pay the employee/beneficiary.

For the purposes of this paper, insurance is taken to mean retirement related products only
provided by insurers. In insurance, the policyholder takes out a commercial contract with an
insurer. The policyholder pays one or more premiums to the insurer and the insurer takes on
the uncertain risk to makes future payments to the insured according to the terms specified in
the policy. Matters can become more complex where, depending on local law, the
policyholder could be
 the employer acting in beneficial interest of the employee through group policies, or
 the employee direct through an individual policy paid for by the employer
and this can have a bearing in practice on factors such as how risk is shared between the
parties.

There are many models in force around the world for delivery of a retirement benefit promise
by an employer. This paper attempts to describe how the nature of the pension promise
changes when the employer has chosen either insurance or a non-insurance mechanism as the
instrument to deliver that promise.

Of course, people do save for retirement in other forms too – e.g. property, self employed sell
their businesses etc. Comparison with other forms of savings are out of the scope of this
paper.

1
Australia, Brazil, Canada, Caribbean, Finland, Germany, India, Japan, Mexico, Netherlands, Russia,
Spain, UK and US
2
The term includes employment offers and other formal documents for those countries that do not
require employment contracts in the literal sense of the term
 2

For simplicity, this paper will term the non-insurance route as ‘pension’ recognising that the
term ‘pension’, as discussed above, covers a broad range of delivery mechanisms in its own
right (pension funds, book reserves etc as illustrated by examples a) to c) above).

The term ‘insurance’ similarly merits discussion as it can mean different things in different
countries according to the interaction of employment and insurance contract law in those
countries. As with pensions, this can lead to an incorrect understanding of risks between what
seem like similar insurance products operating in two different countries. Two core
scenarios arise
1. after the employer has paid the premiums due, the insured benefit is purely a matter
between the insurer and the employee
2. the insurer pays the benefit but the ultimate responsibility (risk3) to see that the
benefit promised through the employment contract is paid, remains with the
employer.

Two common examples of the first bullet are

 where an employer pays premiums direct to an insurer to purchase benefits with the
insurer, e.g. purchase of a deferred or immediate annuity direct with an insurer
 where trustees of a funded pension plan, ‘buy out’ the liabilities by selling assets and
liabilities to an insurer who takes over the legal and economic obligation to pay
benefits going forward.

Two common examples of the second bullet are

 where an employer sets up a pension plan and asks an insurer to manage that plan for
the employer but not insure it, i.e. the employer retains beneficial interest in gains
and losses arising in the plan’s assets and liabilities : this paper terms such a plan a
‘pension’as the insurer is acting in a management not an insurance capacity
 where an employer takes out insurance as a form of asset to help meet the cost of the
pension promise which the employer retains. This is seen in particular in pension
funds where the trustees ‘buy in’ the liabilities by purchasing an insurance policy as
an asset of the pension plan, the pension plan retaining the legal and economic
obligation to pay benefits going forward

Finally, we note that depending on the benefit design and local law there can be interactional
elements between the insurance and pension routes. For example, non-insurable benefits (e.g.
for a classical final pay income plan an insurer will not be able to insure the final pay element
other than as it accrues year by year with any variation being recognised in current or past
service cost) remain a risk of the employer even if the base plan is insured.

3
Which may include the risk of the insurer defaulting when the employer still has the obligation to pay
under local law
 3

Graphically the different scenarios can be summarised as follows

Employer establishes benefit promise

Insurance Non-Insurance
Delivered through an insurance Delivered through a pension fund, book
contract reserve or other non-insured vehicle

Obligation to There are Collectively termed

pay the scenarios where “pensions” in this
employee part or all of the paper
(beneficiary) obligation (risk)
lies wholly may revert back
with the insurer to the employer

Interactional elements like Includes scenario

“Pure Insurer defaults, Non-insurable benefits (eg where an insurer is
insurance” employer re- appointed to manage
future salary growth)
assumes obligations (but not insure) the
(Retrospective) legislative pension obligations
change of an employment law
nature e.g. impact of age
discrimination legislation

Finally a word of caution on terminology. It is tempting to refer to pensions and insurance as

different products – different financial products4 even – and this paper adopts this generalism
as a helpful shortcut. It is important to recognise though that we live in a complex world with
many benefit types, social and labour law models and cultural expectations, it may not always
be appropriate to take this generalism too far.

4
Both pensions and insurance fulfil social policy aims too. They do so in different ways and through
different regulatory means in different countries however as this paper explores below.
 4

B. Overview
In its recent consultation paper "Towards Adequate, Sustainable and Safe European Pension
Systems" the EU re-sparked the debate whether the principles of Solvency II should apply to
pensions.
“The Institution for Occupational Retirement Provision (IORP) Directive’s minimum
prudential requirements include solvency rules for defined-benefit (DB) schemes. With the
entry into force of the Solvency II Directive in 2012, insurance undertakings will be able to
benefit from a three-pillar, risk-based solvency regime and the question is whether this new
regime should also apply to IORPs”

This is not to say that pensions (IORPS in EU terminology) are or must be treated in some
respects like insurance rather that because pensions and insurance share many similarities e.g.
both
o involve obligations to another party (members/policyholders) which may be of long
duration and uncertain in nature
o have assets and future contribution/premiums which together with investment returns
are used to meet these obligations5
o may have access to additional funds (deficit contributions/sponsor
covenant/shareholder funds/free reserves) to meet shortfalls
o are complex mechanisms with significant communication and financial awareness
challenges for employees/policyholders and the public at large
it may be appropriate to consider pension solvency in a similar risk based frame.

Questions arise like

 what is the nature of the promise : is its payment guaranteed or subject to conditions
like employer discretion or affordability
 what social and labour law objectives are sought for pensions and insurance, which
objectives are common between the two product forms, which different
 what regulations are needed to support the delivery of those objectives
 how to measure the obligations arising
 how risk is shared between the parties (employer/insurer and the
employee/beneficiary)
 what capital is required to support the obligation and in what form
 which party ‘owns’ that capital and any surplus/deficit arising

Another key question is whether pensions are in effect a form of self insurance by the
employer and should be treated like insurance for some (e.g. measurement) or all purposes
(e.g. funding). Arguments can be made for and against this proposition. For example,
 from the perspective of the beneficiary, if the employer has guaranteed (through the
employment contract) that the benefit will be paid then the beneficiary will expect to
receive the promised benefit whether the employer has chosen to deliver the benefit
through a pension or insurance route
 however few benefits are guaranteed – there are risks and risk sharing mechanisms
 commercially, the choice between pension and insurance is a matter for the employer
shaped by regulatory, financing/capital and other requirements particular to the type
of product
 from a regulatory and social policy perspective, no country currently has the same
legislation and regulation for pensions and insurance.

5
True for funded pension plans. For unfunded plans, the assets of the plan are implicit in the capital
and return on that capital in the plant, machinery, research, brand etc of the sponsoring entities
 5

Appendix One summarises the principal similarities and differences between insurance and
pensions. The paper goes on to consider similarities and differences in the following key
areas
C. The nature of the benefit provided
D. Regulation
E. Capital
F. Measurement
 6

C. The nature of the benefit provided

Both pensions and insurance incorporate a broad range of benefit designs, within a country
(certainly for countries with a long history of pension and insurance products) and across
countries, reflecting different fiscal and social legislation influenced by different historical,
cultural and political drivers.

Savings/defined contribution products are in many countries provided through both pensions
or insurance in the accumulation phase. In the de-accumulation phase, where annuities are
purchased from the DC pot, it is by far common for these annuities to be provided through
insurance6.

Defined benefit type designs provided through pension funds often incorporate a broader
range of risks than are typically seen in insurance products. Whether this is down to
employers not fully appreciating the nature of the risks they have assumed, unions and other
employee representative bodies successfully negotiating better benefits and options, benefit
designs and governance models that have evolved to reflect changing views of ‘fairness’,
over-riding and sometimes retrospective legislation that has served to strengthen or guarantee
obligations which were previously discretionary in nature, or employers being confident that
they can control certain risks in practice (e.g. pay inflation) is conjecture but it does mean that
many pension plans have become more complex and costly than the original intent and
understanding of the parties that entered into making the benefit promise some time ago.
Given a clean sheet, few employers would establish DB pension plans today.

By contrast, insurers provide insurable benefits. Pure insurance products7 do not (and
should not) assume those risks that are in the employer’s control e.g. pay inflation or other
benefits like early retirement where some form of employer consent is required.
Discretionary indexation can be provided through participating insurance business.

Where such benefit design features are seen in arrangements with insurers, the employer
finances them in the form of additional premiums as and when the additional benefit is
triggered – in effect, a current unit type actuarial method is adopted. In other words, when the
moral hazard is removed the risk becomes insurable8.

Further, where (retrospective) legislative change is considered to be employment related in

nature, often the impact falls on the employer even if the plan is insured.

Example 1: In the early 1990s, the European Court of Justice ruled that, across the European Union,
men and women had to have the same retirement ages notwithstanding that different retirement ages
had been contractually agreed and in force for decades. Employers had to change new hire and
existing employee employment contracts to ensure compliance with the new employment law,
including changes to retirement benefits under those employment contracts.. For such benefits
provided through insurance contracts, typically contract law was deemed not to have been breached
but employment law had been. Thus, the additional cost of providing benefits to the (unfairly)
disadvantaged group of employees of equal amount to the group deemed to have been (unfairly)
advantaged 9 fell on the employer not the insurer.

Example 2: In some countries (e.g. Belgium, Germany) the ultimate obligation to deliver a certain
minimum benefit under a Defined Contribution plan ultimately lies with the employer and not the
insurer.

6
Examples of DC and DC type products sometimes provided through pensions in the de-accumulation
phase include fixed term annuities (US, Japan) in cash balance plans, and where an employer has a
standing DB plan paying annuities in retirement of which the DC plan is part.
7
Where an employer sets up a pension plan and asks an insurer to manage that plan but not insure it,
i.e. the employer retains beneficial interest in gains and losses arising in the plan’s assets and liabilities,
this paper considers such a plan to be a ‘pension’.
8
It can also be said that the employer does not “insure” e.g. future pay growth in advance : the
beneficiary doesn’t have a right to future pay growth in the benefit design until the pay growth happens
9
Alternatively, the employer could seek the agreement of the advantaged group to give up part of their
benefits to the benefit of the disadvantaged group
 7

Another major difference between pensions and insurance is in relation to security.

Non-participating insurance is contract driven : security is a legislated feature factored into

the price of the product. Historically, in many countries, pensions were a best endeavour by
the employer dependent on affordability and encouraged by a favourable tax system. This is
consistent with the employee carrying out a service of imprecise value for the employer
whereas insurance is an arms length financial contract paid for by a defined premium. A
general impact of changing legislation over time is that security of past service benefits has
become a harder feature of pensions. DB pensions are increasingly seen by regulators and
employers alike as a business obligation that needs to be managed as part of the employer’s
total business assets and obligations conscious of the social and political aspects of change.
Benefit designs built around greater risk sharing between the employer and the employee are
being seen in all the major pension liability countries.

In participating (with-profits) insurance, policyholders have paid higher premiums (a ‘bonus

loading’) than necessary to deliver a stated level of guaranteed benefits and have expectations
(subject to investment performance/affordability) of additional benefits. This is similar to the
concepts in pensions of constructive and discretionary benefits such as salary growth or price
inflation – the better one’s career, the higher your pension will be. Two key differences
however are that in participating business
 there is greater compulsion on the insurer to share profits than there is on the
employer in pensions to apply its discretion to increase benefits : insurance regulation
often specifies that a high (80+%) proportion of the profit arising must be allocated to
policyholders, and
 the assets from which bonuses are declared are well defined. In contrast, the capital
that is represented by the employer covenant in pensions is neither clearly defined nor
ring fenced for the purpose of discretionary benefits10.

10
Escrow funds and ringfenced assets are a means of establishing short term security whilst a funding
deficit is made good over time through increased contributions or improved investment performance.
Such collateral is for the security of the existing benefit promise not for the provision of increased
future benefits.
 8

D. Regulation
Benefits delivered through employer pension mechanisms (funds, book reserves etc) and
those insured through insurance contracts have experienced regular, some might even say
constant, regulatory change. The nature of those regulatory regimes are however different.

Regulation of defined benefit pensions has tended to be lighter touch and less risk focussed
in nature,11 built around
– spot valuations based on deterministic (prescribed or best estimate) assumptions
– no additional solvency or risk margin capital requirements12
– medium to long term deficit recovery periods
– disclosure requirements that are typically less onerous than a quoted company would need
to provide to its shareholders13
– quantitative or prudent man investment restrictions to provide some measure of downside
solvency protection14

This approach seeks to balance three factors

– encouraging employers to provide (DB) pension provision
– commercial cost to the employer of doing so
– member security and socio-political risk if/when employers default on their (DB) pension
commitments.
recognising also that there are many pension plans in mature economies and regulators are
usually not in a position to be able to commit resources to take other than a light touch or
arms length approach to monitoring all but a small percentage of those pension plans.

Critically pensions regulation relies on

– the ability to access the employer’s covenant should this need to be called upon
– regulatory checks and balances coupled with a sound governance platform at plan level
designed to promote desired behaviours15
Some have termed pensions regulation as a soft capital regime.

Getting pension regulation right is a delicate balance because when an employer fails (or an
employer walks away from, or changes adversely, its obligations) and (expected) benefits are
not paid in full, there can be socio-political fallback in response to what may be viewed as
inadequate member security. This tends to lead to calls for stronger funding or other
regulation16. The social element of pensions can lead to political pressure also in good
scenarios : when DB pension funds have been in substantial surplus (e.g. towards the end of
equity bull market runs) there have been calls for increased benefits either of a ‘voluntary’
nature or mandatorily in the form of ‘quality tests’17. E.g. granting of guaranteed increases to
DB pensions in deferment and retirement in the UK.
11
The US, through ERISA legislation, could be argued to be an example of heavier, more rules based
regulatory system. The regulatory aspects are heavier in the areas of plan design, reporting and
administration than, for example, in funding which is primarily law based. US funding requirements
do not have a strong risk focus.
12
Netherlands is the main exception : buffers must be held to ensure a high likelihood that benefits
will be paid. Spain also requires a solvency margin of 2% on DB pension liabilities. Other countries
could be said to utilise risk margins indirectly by adopting a deliberately cautious discount rate : in
practice, this approach is rarely seen as employers don’t look to overfund their pension obligations as
this means taking working capital out of the business and it is difficult to return surplus to the
employer. More likely, to provide a greater floor on funding levels, employers and trustees could agree
on the use of contingent assets such as escrow accounts which do not take effect unless funding falls
below a pre defined level
13
A particular example would be disclosures a quoted insurer would make to its shareholders or
providers of capital in general
14
There are also explicit limits on self investment – typically at the 5% or 10% level. As an aside, the
deficit in a pension plan seems to be universally excluded from the definition of self investment
notwithstanding that for many plans in deficit, the employer covenant backing the deficit may be the
biggest single asset of the pension plan
15
Including knowledgeable trustees (or similar body) to run the fund independent of the employer
16
The concept is not limited to pensions. For example, the failure of Equitable Life in the UK has led
to new insurance regulations and practices.
17
There is an indirect parallel with calls for the distribution of orphan assets in insurance
 9

Insurance regulation tends to be more dynamic in nature with explicit recognition and
modelling of risks to quantify and disclose hard capital requirements to ensure payment of
contractual benefits to policyholders18. Regulation through capital is considered to better
align shareholder and regulatory interests19 20. However the recent financial crisis has
strengthened claims for regulation through additional (non-cash capital) factors and to
mitigate systemic risk. In Europe, Solvency II aims to have both quantitative (pillar 1) and
qualitative (pillar 2) elements.

It is instructive to think about how the direction of pension regulation, and the role of the
regulator in particular, is changing in Europe and in the UK in particular. The UK regulator is
focussed on maintaining the direction of travel of existing regulation
 greater risk management (through adoption of mark to market approaches, reduction
in asset/liability mismatches etc)
 strengthening of measurement assumptions (technical provisions in UK terminology)
 reduction in deficit recovery periods

This aligns with the thinking of CEIOPS (now EIOPA), which has a joint insurance and
pensions regulatory overview brief at EU level. CEIOPS identified four principles which
should underpin a supervisory framework
 forward looking risk based approach
 market consistency for solvency purposes
 transparency
 proportionality
with particular regard to insurance.

How these principles would apply to pensions across Europe is to be discussed through 2011.
As noted earlier in this paper, it is not necessarily the case that application of the principles to
pensions should be the same as for insurance. Even if the intellectual argument were proved,
there are a number of regulatory and practical difficulties in trying to apply the same or
similar approach to pensions as is applied in insurance. Not least, how to incorporate and
monitor soft (i.e. non-cash) capital (sponsor covenant etc) and ownership of any explicit
solvency capital in the pension scheme21. The Groupe Consultatif provided some initial
thoughts on this in Appendix E to its 2010 report on security of IORPS.
http://www.gcactuaries.org/documents/IORPSecurity_full_May2010.pdf

18
For example, UK insurers must hold capital sufficient to cover 1 in 200 events (99.5% certainty) on
the models adopted. Also the UK regulator is clear it is not operating a “non-failure” regime
19
This statement balances risk and reward – lower capital requirements generally means shareholders
get their returns quicker but they would have a higher risk of the need for future capital injections than
if higher capital requirements had been in force. It also means that shareholders have to view
regulatory risk as a factor in the insurer’s capital requirements.
20
Does regulation through capital also align policyholder interests? At first sight, implicit in this
statement is that the policyholder pays higher premiums to enable that benefit security. However this is
not necessarily the case. For policies already in force, higher capital requirements fall on the insurer so
generally speaking reduce shareholder returns if the insurer cannot pass the cost of that capital off onto
policyholders (i.e. price elastic business). For policies yet to be written, fewer people may buy the
policy if premiums are higher.
21
In particular, asymmetric effects in pension funding in many countries whereby employers are
required to meet deficits but it is often difficult (if not prohibited) for employers to access surplus.
Even where legislation permits access to surplus, the surplus often has to be shared with beneficiaries
or the taxman
 10

Germany is a good illustration of the practicalities of the interaction between different

regulatory regimes built up over time for different products - funded pension, unfunded
pension and insurance products. In summary,
(a) Promises made directly from sponsor to participant in the form of an unfunded benefit are
not regulated in terms of minimum capital requirements other than a book reserve must be
established and local GAAP accounting conditions met
(b) ‘Support Funds’ also do not have minimum capital requirements
(c) Pensionsfonds: Regulation under insurance law but distinct from (d) and (e); can be less
onerous than (d)
(d) Pensionskassen: Regulation under insurance law but distinct from (e) and generally less
onerous than e)
(e) Direct insurance or re-insurance: Regulation as for insurance companies
 11

E. Capital
DB pensions may be (part) funded through assets explicitly held for that purpose (through a
pension fund or otherwise earmarked) or (part) unfunded with reliance on the strength of the
employer’s balance sheet22. Whether sufficient assets are held at any given time to be able to
meet the promised (or expected) benefits is unknown23 and is managed over time at both the
plan and employer level. For example
 Payment of additional contributions or commitment of actual or contingent security
 In some countries, the nature of the benefit may be dependent on affordability, e.g.
the funding level in the plan. That is, the promise has both DB and DC elements
 In many countries, the employer can take action to amend or terminate pension
benefits to mitigate its obligations. By contrast an insurer may only be able to stop
writing new business but is contractually obliged to continue writing current business
even if it is loss making.

Insurance operates in a fundamentally different way. It is a risk focused business activity

designed to pay out its contracted obligations in all but the most extreme economic scenarios.
With time, it has become a business where insurers operate internationally such that although
different types of benefit and product designs may be provided across borders, insurers
increasingly operate to similar industry and regulatory standards.

Capital provides security to policyholders against the failure to deliver benefits24. Capital has
become the primary means to regulate and operate the global financial (insurance and
banking) market. Because capital is expensive, using it efficiently and effectively is key to
the operation of a competitive insurance market. Insurers around the world utilize similar
techniques and approaches to manage capital.

If pensions and insurance represent different delivery mechanisms for deferred pay, are they
in competition for business or capital? For the accumulation phase of DC provision, they do
compete in many countries today and were insurers to broaden their product ranges, or
employers align their HR and other goals, pensions and insurance would likely compete to a
greater degree in those and other countries also25.

Although there are many parallels between pensions and participating insurance, it is not clear
that pensions and insurance are in competition for DB provision however
o they are different markets
 DB pensions are a bespoke, internally focused or ‘closed’ market i.e. operated by a
given employer for its employees only. Whereas insurance seeks competitive
advantage from mass market one-stop-shop products to provide advantages of scale
and risk pooling.
 Insurance and pension products within a market have different regulatory and
sometimes tax requirements and an employer’s choice of which product to take is as

22
The measurement basis used for pension liabilities impacts the pace of funding for funded plans. It
may also impact the security of benefits for unfunded plans. This is because financing and operating
decisions of the business are taken relative to the pension liability disclosed over time on the
company’s balance sheet – for funded plans, this is typically the liability net of the assets held
independently of the employer but for unfunded plans, it is the full liability. If the measurement basis
used over time doesn’t reflect the cost of providing pensions to a high level of security then, if and
when the company is liquidated in the future, the residual assets of the company (for a funded plan,
together with the assets held in the pension plan) may not be sufficient to pay pensioners their benefits
in full.
23
Except in the special case where either i) the assets are cashflow and risk matched to the liabilities,
or ii) the plan is terminated and benefits bought out with an insurer or otherwise cashed out in
accordance with the plan rules
24
Capital requirements can be mitigated in part through risk sharing mechanisms e.g. with-profits
arrangements
25
A particular, but not significant in volume terms, UK example of competition between insurance and
pensions could be in the area of Additional Voluntary Contributions (AVCs) where a pension plan
member makes additional savings through the plan which are then used on retirement to buy a pension.
Some UK pension plans allow the member to either purchase a pension from the plan using these
AVCs on terms set by the trustees or an annuity from an insurer.
 12

often based on these factors as well as the principle of risk transfer through insurance
or risk retention through a pension product. In Spain, for example, an employer can
tax optimise its finances by using both an insurance product (GIP) and a pension
product (CQPP) for different parts of the benefit design
 Insurers have been particularly successful in attracting pension business of small-
medium employers in many countries, it is important to distinguish between
situations where the insurer acts simply as a manager of those funds (the employer
retaining the risks) and those where the pension is insured with the insurer (i.e. the
insurer bears the risks, or at least most of the risks). Taking three of the world’s
largest pension obligation countries by way of example
 Netherlands has a balance of both types of business for insurers
 In Japan, true insurance of pension products is rare
 In the US, insured pension business primarily takes the form of buy-out
policies for plans in wind up.

o different risk appetites of the parties involved including factors such as benefit design and
investment strategy
 Perhaps because of the soft capital approach in pensions (contingent reliance on
employer’s covenant etc) employers/trustees are more inclined to take asset-liability
mismatch risks and benefit designs have broader HR or social objectives containing
more risky elements (salary growth, guarantees and member options, discretionary or
conditional indexation) than are typical for pure insurance products
 Although insurance is designed to ensure payment of benefits in all but the most
extreme scenarios, there isn’t a similar framework in pensions on a plan by plan basis
(with the exception of the Netherlands and the possible exception of the UK26)
 It would be interesting to reflect on what pension plan members think the risk of non
or partial payment is in the plan they are a member of. And both what an acceptable
risk of non or partial payment would be and what the member would be prepared to
give up to increase security27

o with different regulation overseen often by different regulators

 In simple terms, pensions operate by a soft capital regime with checks and balances,
and insurance is a hard capital risk-focused regime. In Europe, directional alignment
on regulatory aims and themes, though not necessarily application of those themes,
seems likely
 Pensions and insurance contracts have different legal bases and ‘pressure valves’ if
obligations become too onerous. Law generally provides for more flexibility for
employers to amend the terms of pension plans/promises in difficult economic
circumstances. Insurance obligations can generally only be amended prospectively to
the extent permitted by the contract boundary clause

o and although many countries operate guarantee arrangement (government or

industry sponsored investor protection or financial compensation schemes) in the event an
insurer defaults, few do so for pensions28 and different arms of government/industry are
responsible for each.

26
Dutch provisions are designed to ensure that the minimum funding requirement (liabilities are
105% funded) is met 97.5% of the time, i.e. 39 out of 40 events. This implies a target funding ratio of
130%. It can be argued that the UK does have a form of plan by plan security framework in that the
regulator can impose stronger pension funding (technical provisions and/or deficit recovery and/or
Pension Protection Fund levies) requirements on an employer with a weak covenant
27
For example, would an employee be prepared to accept a salary that is below the market for the job
if the job also came with a DB pension? And would the answer differ for senior management in
unfunded top-up plans compared to line staff in the main (possibly funded) pension plan? We can also
think about the question in reverse : what lump sum would a member of a DB pension plan today be
prepared to accept in lieu of their current pension? - this question has been the source of some
controversy in the UK in terms of the regulatory response to employers offering members so-called
‘enhanced transfer values’ to reduce the plan’s DB risk exposure.
28
US, UK, Germany, Switzerland and the Canadian Province of Ontario provide State or pseudo State
insolvency arrangements funded by levies on all employers with pension plans
 13

F. Measurement
Actuarial measurements fall into two main categories – matching and budgeting calculations.
The calculations differ in the nature and extent to which they embed risk into the discount rate
used. Matching calculations set the discount rate independently of the assets held instead
having regard to the nature of the liabilities29. Budgeting calculations have some regard
(implicitly or explicitly) to the nature of the assets held.

There are examples of both in pensions and insurance – see Appendix Two for an analysis of
measurements in use in actuarial work in the UK.

In many countries, local GAAP accounting requirements for insurance have been aligned with
statutory reporting requirements. Typically this involves setting the discount rate equal to
a percentage of the
 gross redemption yield on bonds
 dividend or earning yields on equities and property
held by the insurer. Through market consistent valuation or otherwise, allowance is made for
policyholder expectations of interest in participating business.

In Europe, Solvency II is adopting a mark to market approach for regulatory reporting of

assets and liabilities based on use of nil risk discount rates (termed the reference rate)30
adjusted for the illiquidity of the liabilities31, plus explicit risk margins using stochastic
modelling and other techniques.

The IASB have also exposed a revision to IFRS 4. This is based on a fulfilment measurement
objective, that is that the entity expects to fulfil its obligations over time. IFRS 4 is broadly
consistent with the Solvency II approach assuming fulfilment value embraces the concept of
an illiquidity premium. It proposes that the accounting measurement
• should allow for probability weighted cash flows and the time value of money
• the discount rate should reflect the yield curve for instruments with negligible risk
(nil risk rate) adjusted for differences in illiquidity of the liability
• add risk margins that reflect the maximum amount the entity would rationally pay32
to be relieved of the risk that insurance payments will ultimately exceed those
expected
• adopt a residual margin to amortise profit at the time of sale over the life of the
contract

For DB plans, pension funding measurements differ quite broadly in approach and
conservatism between jurisdictions. Budgeting and matching approaches are seen : in
particular, budgeting approaches can be argued as natural for pension regimes which have
been built around the soft-capital that is the sponsor’s covenant.

The basis and choice of assumptions varies widely in “strength” from country to country as
funding measures may be prescribed by local regulations, or determined by the trustees or
actuary in consultation or negotiation with the employer.
 The discount rate can either be formed independently of the assets held to pay the
liabilities in funded plans, or alternatively bear some regard to the plan assets

29
For clarity of use of language, a matching approach quantifies only the risk implicit in assets with a
cashflow profile that matches that of the liabilities. A matching approach does not in itself quantify
other risks
30
Because DB pension plans and (life) insurance both can have liabilities with a duration that in many
countries is longer than that of available matching assets, where the discount rate is based on market
yields extrapolation techniques are required to discount the long tail cashflows.
31
In insurance and pensions, the policyholder/member rarely has the option to transfer a DB
contract/benefit to a third party [the UK is a notable exception where by law members of a pension
plan have the right to take a transfer value to another pension arrangement – albeit the take up rate is
low for other reasons]. Therefore the insurer/plan can seek competitive advantage through investing
part of its assets in lower marketability investments and enjoy the illiquidity premium in their pricing.
32
Not necessarily the same as the market price of effecting a buy out or reinsurance policy.
Fulfillment value is therefore not necessarily the same as settlement value.
 14

expected to be held (i.e. use a different, typically higher, discount rate being used
where a greater proportion of the plan assets are invested in equities rather than bonds
 The other assumptions are either prescribed or tend to be best or prudent estimates in
nature. Although stochastic approaches are widely used in investment strategy and
for management and ad hoc work, deterministic approaches remain the principal
method for determining funding targets. Risk margins are unusual other than where
they are implicit in the use of a prudent deterministic assumption
 In practice, both accrued value (i.e the current benefit amount based on current pay
and no allowance for future inflationary impacts on the benefit - ABO) and projected
value (i.e. the current benefit amount increased for expected future inflation (pay,
prices, medical) - DBO) based measures are in force around the world.

There are two types of pension accounting

a) the accounting for the plan’s liabilities in the accounts of the plan itself (where the
plan has a legal or quasi-legal existence and must produce its own accounts under
local GAAP)
b) the basis by which pension obligations are reported in the accounts of the sponsor
company
By contrast, the core business of the insurance company is insurance such that a) and b) are
indivisible for an insurer.

Under many countries’ local GAAP, the liabilities of the pension plan are not recorded in the
plan’s accounts. The plan’s accounts in effect form a P&L statement only. Where the
liabilities are recognised, the figure shown is typically prescribed or tends to be that from the
funding valuation.

Pension liabilities as recorded in the accounts of the sponsor company are by contrast
invariably matching calculations in their nature. The trend continues as more countries adopt
IFRS. The IASB are considering a fundamental review of the international pensions
accounting standard, IAS 19. This could include applying some of the central measurement
principles in the proposed IFRS 4 to projected pension cashflows as illustrated in the table
below.

IFRS 4 Current IAS 19

Nil risk discount rate adjusted for illiquidity
of the liabilities
Explicit risk margins34 incorporating
 liability measurement, and
 asset measurement
No reserve held for non-insurable risks
Participating business includes allowance for
policyholder expectations
Residual margins to amortise profit at the
time of sale over the life of the contract
High quality corporate bond yields 33
None. Liabilities determined using
 Best estimate assumptions
 N/A
DBO approach including allowance for constructive
obligations like future pay growth in final pay plans
DBO approach including allowance for indexation and
other discretionary practices where there has been a
history of such practices. Or for conditional indexation
where affordable.
N/A 35

Key to the measurement question for pensions is, in addition to the differing types of benefit
design in force globally, whether and how to measure the different employment law, delivery
vehicle structures and ‘pressure valve’ mechanisms in force globally (see Appendix One).

33
This is often referred to as AA corporate bonds however that is a proxy and like all proxies must be
used with care. During the credit crunch, many commentators questioned whether some of the bonds
which comprised the rating agencies’ AA indices (which were often only updated at the end of a
quarter) were truly high quality.
34
A Liability Adequacy Test principle applies with the risk margin built up from component factors
Should the risk margins prove unnecessary, further profit arises
35
It could be argued that by using a higher discount rate than would an insurer, the pension measure
already assumes an element of future ‘profitability’ for the sponsor from investing the assets of a
funded plan in a non-matched portfolio, or in the assets of the sponsor’s business for an unfunded plan
 15

What is a contractual obligation (‘accrued right’ and similar pension concepts) in one country
may be a contingent obligation under law in another country. Should contingent (or
discretionary) obligations be measured as if they were contractual in nature? Does that
provide for a fair value or a prudent value (as it would assume that the scenarios that would
trigger the contingent nature of the cashflows in question never arise, or that discretionary
practices from the past can never change in the future)?

A similar question arises in insurance regarding establishing reserves now for the
beneficiaries’ share of profits that will hopefully emerge in the future under participating
contracts.

Changing regulatory environments may also impact the discount rate used in the
measurement, specifically whether allowance for sponsor default on obligations is taken. In
the UK, and increasingly across much of Europe, authorities are looking for stronger
commitments from sponsors to their pension obligations and in some countries perhaps this
could lead one day to guarantees equivalent to those for insurance obligations. Highlighting
the additional cost of these guarantees in funding reports and accounts through the use of
closer to "risk free" discount rates is logical.

Finally, although they bring many advantages to employees/policyholders, it can be said that
the presence of guarantee arrangements in the event of insolvency of either pensions or
insurers creates a moral hazard on employers, trustees and insurers around measurement and
financing/funding.

For example, moral hazard can arise from factors like i) inaccurate pricing of plan and plan
sponsor risk by the guarantee association and ii) from the plan sponsor being able to
unilaterally create past service benefits (this is mitigated from the perspective of guarantee
association if the guarantee association discounts benefit improvements made within a certain
number of years of the insolvency event ; however that is of little comfort to the beneficiary
who gets a lesser benefit than they had expected). In the UK, the management of this actual
or assumed moral hazard is a core part of the brief of the Pension Regulator and the Pension
Regulator has been diligent in managing it, including one high profile court cases where it
considered it necessary to defend the Pension Protection Fund from the actions of the trustees
of one underfunded plan with a financially weak sponsor that were looking to invest the
fund’s assets aggressively in the knowledge that if the investments underperformed the
Pension Protection Fund would pick up the (enhanced) deficit when the sponsor defaulted.
 16

G. Summary
Pensions and insurance represent different mechanisms to deliver a benefit promise from the
sponsor to the beneficiary. It is not surprising therefore that they bear many similarities.

Both involve obligations that carry out a key social purpose to a third party and which
obligations are typically of long duration (perhaps 60 or more years) and uncertain in the
amount and timing of cashflows arising.

The obligation arises from the employee carrying out a service (their job) for their employer,
part of the reward for which takes the form of deferred pay.
 If the employer elects the insurance route, it pays a premium today for which the
insurer takes on the risk to pay the insured benefit to the beneficiaries in the future.
As noted in the Preliminary section of this paper, there are instances and countries
though where the employer retains risk even if the employer elects to finance its
obligations through insurance. As a statement of the obvious, insurance contracts do
not necessarily cover all the risks or the same risks everywhere.
 If the employer elects to finance its obligation through a non-insurance (‘pensions’)
route, the employer retains all of the financing risk and, depending on law, may fund
the benefit in advance or otherwise record the liability on its books.
Insurance is a hard capital regime, pensions a soft capital one. Participating insurance
contracts are perhaps somewhere in between.

Like insurance, funded pension plans collect and invest assets and future contribution/
premiums which together with investment returns are used to meet these obligations. And
both may have access to additional funds (deficit contributions/sponsor covenant/shareholder
funds/free reserves) to meet shortfalls.

There are a number of key differences also. Primarily the history of the products, how risk
sharing mechanisms operate, the nature of the regulatory regimes – in particular, the pace of
funding/financing and the ability of the insurer/employer to change the terms of the
contract/plan in difficult times – and governance that have built up over time to shape
people’s perceptions.

Employment law shapes pension products (and may shape insurance products in some
countries also). The concept of accrued rights accords well with the insurance concept of
contractual benefits and the accounting concept of contractual obligations. But not all
countries operate accrued rights rules – employers or trustees (or their social partner
equivalents) may be able to change benefits retrospectively if circumstances merit or
agreement is reached otherwise.

Insurance is an international business : through the IAIS, IASB and industry competition, the
basis of statutory reserving, capital requirements and accounting for insurance business is
converging. Particularly in Europe through Solvency II. Features of pensions like
measurement, funding and governance are driven by in-country regulation, country social and
fiscal preferences, market depth and size, culture and country politics. The EU aside, cross
border influence on pensions is through bodies like the OECD, the World Bank, professional
bodies like the actuaries, and businesses (employers, product providers and advisers etc) who
operate internationally. They promote greater alignment through sharing of experience and
best practice in benefit design, operational efficiency, and regulatory models and oversight.

It is often noted that insurance is more expensive than pensions : this is not representative of a
difference between the two products however. Rather the seeming extra employer
contribution (premium) in insurance, over and above what may be seen in pensions36, is

36
The cost of a pension is viewed differently by different parties. The actual cost of a pension can
only be determined when the last beneficiary dies and all the actual cashflows known. The short term
cash cost is the funding contributions over a given time period. The short term accounting cost is the
charge to the accounts over a given time period. Risk (financial, demographic, regulatory, political) is
the expensive unknown until the last beneficiary dies. Some of these risk factors can be mitigated by
purchasing matching assets.
 17

consideration for the risk transfer in insurance. The absolute and relative costs of both
insurance and pensions can be mitigated in part through the policyholder taking on more risk
such as participating insurance contracts or more defined contribution elements in the pension
design.

Perhaps the key difference is that because insurance is a hard capital regime, there is greater
clarity in the operation of the insurance contract (who bears what risk and who benefits from
that risk, what capital is required etc) although participating insurance arrangements in
particular are still criticised for lacking transparency. This flows through to
 Greater clarity about inter-generational wealth and risk transfer
 Ringfencing of the capital available to finance the contract
 Who benefits from surpluses, suffers from losses
 What the parties risk appetites look like accordingly
These themes are also addressed in pensions of course but through different mechanisms set
at country and plan level.

A critical question remains however whether regulators, employers, employees and

beneficiaries whose retirement benefits are covered by an insurance contact (whether
participating in nature or not) or a pensions vehicle (whether defined benefit or defined
contribution in nature, funded or not) have an equal understanding of the nature of the risks
they face under those products and any national or industry level guarantee arrangements in
place around them. Actuaries have a key role to play in ensuring sound levels of financial
awareness and understanding of products.
 18

Appendix One – Summary of Similarities and Differences between Pensions and Insurance
Pension Insurance
The employer agrees to provide deferred pay (the ‘benefit’) in return for the service of the employee through and as part of the employment offer/contract. The
employer can provide the benefit through an insurance or non-insurance (pension fund, book reserve etc) route.
Construct
The employment offer/contract may guarantee the benefits promised or the benefits may (in whole or in part) depend on the discretion of the employer
motivated by goodwill or affordability (on payment of the benefits). What may at first sight look like a DB benefit may in fact have DC or DC type elements.

Range of vehicles such as A commercial contract whereby one party (the insurer) accepts significant
 pension funds/foundations insurance risk from another party (the policyholder) by agreeing to compensate
Product  book reserves the policyholder if a specified uncertain future event (the insured event) adversely
 pay as you go arrangements affects the policyholder. The policyholder pays one or more premiums to effect
the contract.
Very broad range of benefits nationally and globally. Can be Very broad range of benefits nationally and globally, albeit the products may not
 DB or DC in nature be the same as, nor necessarily compete with, those provided under pension
 Depending on tax rules, payment in lump sum or annuity form vehicles due to tax, target market, market penetration or other reasons.

For salary related plans, the employer bears the risk of salary growth (over A key difference is that the insurer may not insure all the risks inherent in the
Nature of which the employer has some control). Similarly for plans with early pension promise. Certain risks like enhanced early retirement terms, pay inflation,
benefit retirement or discretionary benefits like indexation in deferment or or discretionary benefits may not meet an insurable test as they are in the control
retirement. of the employer or government. Instead they would be insured (subject to
additional funding from the employer) as the additional benefit arises.
Additionally for plans linked to State/social security benefits, the employer
bears the risk of social security evolution (over whichthe employer has no
control).
Many countries operate accrued rights type regulation whereby once a The insurer may only to the extent the policy includes an explicit provision to do
benefit has accrued and vested it cannot be taken away. [In insurance so (e.g. policy boundary) or by request of the insured.
terminology, this would be termed a ‘contractual benefit’.] The employer
Ability to
has freedom to change the terms of the plan otherwise and for future service The policyholder has no general option to change the terms of the policy other
change the
in particular, subject in both cases to labour relations issues 37. In practice, than to effect certain options that may be written into the contract, or in a regular
benefit promise
this could include replacing a DB plan for future accruals by a DC plan or premium policy to stop paying the premiums and in so doing terminate or pay up
higher pay. the policy according to its terms.

37
Where employment law operates under strong social principles, e.g. Japan and Netherlands, the employer cannot unilaterally change terms including terminate the plan .
 19

Not all countries have an irrevocable concept of accrued rights however For participating contracts (like with-profits), the policyholder shares the risk that
 pension rights are negotiable in [many countries] if the employer the expected benefits may not materialise.
(or the pension fund which provides the benefits) is in financial
difficulty or by social agreement otherwise
 the trustees/foundation board may determine the benefits payable
(eg Netherlands) given the funding available

The employer can also elect to terminate the plan, buying out accrued There is no general equivalent in insurance. The insurer remains on risk for the
benefits with an insurer or, if law and plan rules permit, encashing them whole of the contract period (though where the contract has a ‘contract boundary’
direct to the employee. clause the insurer can vary the terms of the contract after a period of time or a
specific event).
Depending on the plan rules, these may be determined There is no direct parallel in insurance save possibly special distributions of free
 by the trustees from surplus assets, or reserves.
 by the employer Regulations in many countries provide that participating contracts share a high
Discretionary
from time to time to meet prevailing social goals, subject to affordability or proportion (e.g 80+%) of the insurance profits made on like business with
benefits
additional funding. policyholders. How profits have been shared over time supports the concept of
policyholder expectations which are viewed by the IASB and others more like
constructive than discretionary obligations.
Three layers Two layers
 Terms of employment offer and prevailing policies  Commercial insurance contract written under insurance law
 Employment law ; and  Pensions law (where such also applies to insured products)
 Pensions law (where such exists)
Legal structure
Note : contract legislation (both employment and insurance) differs from country to country whereas accounting is converging on international standards.
Prudential regulation is also converging, certainly in Europe, but globally also albeit more slowly.

Benefit can be provided directly by the employer (book reserves etc) or Contract written by a commercial, profit-making organisation (the insurer) which
through a not-for profit vehicle with quasi-legal status, like a pension fund may have external (proprietary) or internal (mutual) shareholders.
or similar arrangement, established by the employer for the specific
purpose.
Means of
Such mechanisms are typically operated independently of the employer or
delivery
within prudential guidelines. It has rules which define what is payable,
when, how financed and which parties are empowered to take what
decisions around the operation of the fund.
 20

Depending on social and labour law, governance is usually exercised by one Board of Directors of the insurance company operating within
or more of the following  General Company law ; and
 Trustee or equivalent body  Specific insurance law & regulation (a key feature of which is often to
 Social committee like a works council treat the policyholder ‘fairly’)
Governance
 Employer
A system of checks and balances is common over key decision making. Increasingly, national regulators and supranational bodies like the IAIS and IASB
Unions are increasingly taking an interest in governance. are bringing additional transparency into reporting enabling better comparison of
Funded pension plans are typically subject to audit by an external auditor. the financials and operation of insurance companies within markets and globally.
By a specific pensions regulator (if any e.g. India currently does not By a specific insurance regulator. In the US, insurance regulation is at State level
regulate the occupational pensions sector)
Regulation Typically, the pensions regulator is established and operates independently of the insurance regulator. In some countries, e.g Netherlands, Finland, Jamaica,
Trinidad and Tobago, the two are the same body though the form of regulation may not be the same. At EU level, CEIOPS (soon to become EIOPA) has been
formed to look across both pensions and insurance, though again the form of regulation is currently not, and may not in the future, be the same across both.

Typically not or only partially risk based in nature. Risk based supervision principles are common
 minimum capital requirements on a market consistent basis
Assets and liabilities may not be determined on a market consistent basis,  risk management
e.g. through smoothing techniques, though a market consistent approach is  transparency and disclosure
becoming increasingly common through the influence of supra-national
Prudential rules
bodies like the IASB. Assets of a quality determined by the regulator must be sufficient to cover the
of operation
total of the liabilities. There is greater investment freedom for free reserves.
Funded plans must invest in assets that meet quality tests determined by the
regulator. This can take the form of a prudent man test / principles (e.g.
most of EU) or quantitative restrictions (e.g. Switzerland, Norway).

Retirement benefits are valuable but often complex for employees/beneficiaries to understand. Whether provided through insurance or a pensions vehicle,
regulation, politics, employment law, tax rules and the particular risks of each product interact to make the product often a challenging one to communicate
Financial well, Thorough communications are necessary to ensure understanding and to mitigate risk., As the beneficiary of a pension plan is often subject to more
awareness & downside risks than a policyholder to an insurance contract, there is a greater challenge for those in the pensions industry to ensure financial awareness and
Communication understanding of pension products. Insurance is also criticised in some quarters for the lack of transparency in some products notably risk sharing in
participating business.

Tax systems are set at country level to meet fiscal and social aims. Pension type products provided through insurance or through pension funds often share the
Tax same tax systems but it is not guaranteed that they do e.g. they differ in Canada. In Germany, the tax system is largely neutral (to first order) to the employer
between insuring and book reserving the liability. In Turkey, there are limited tax breaks for DC provision but no tax breaks for pre-funding of DB provision.
 21

Different measures can apply for different purposes and be set by different Similarly, different measurements apply for different purposes.
parties accordingly. Measures may be based on expected asset returns or be
independent of the assets held. Measures are made for
 regulatory reporting
Funding measures are set by local law and may involve  accounting, and
 prescribed by local regulations, or  for management or modelling purposes, including enterprise value
 determined by the trustees or actuary in consultation or negotiation assessments.
with the employer In practice, ABO type measures are the more common. Risk margins are
In practice there is a mix of ABO and DBO measures in force included, either explicitly or implicitly.
Asset and
internationally.
Liability
The business of the employer sponsoring a pension plan is usually something
measurement
Accounting measures may relate to the other than pensions. However the business of an insurer is insurance and there is
 accounts of the plan itself : typically plan accounts focus on P&L a trend to using the same or similar based measures for regulatory and accounting
impacts only purposes (and that the liability measurement is independent of the assets held) to
 accounts of the sponsor : determined by the directors of the sponsor ensure greater transparency to regulators, investors and policyholders alike of the
within local or international GAAP operations of the insurer.

Measures may also be made for ad hoc management or modelling purposes,

akin to enterprise value techniques in insurance.

Funding requirements are set by local law and may involve:
 a prescriptive minimum funding level supplemented by discretionary
funding agreed by the employer over and above that level, or
 a negotiation by the employer and the plan trustees (or equivalent
body) on the level of funding that should apply
Funding/
The level of funding is conditioned directly or indirectly by the strength of payments due. For participating contracts, the policyholder shares in the risk that
Capital
the employer’s covenant. That is
 assets + covenant = self sufficiency
Insurance regulation sets out minimum capital requirements equal to the expected
payouts under the policy plus risk margins to cover adverse experience.
The insurer sets the premium to cover these requirements having regard to the
reserves held by the insurer. The insurer invests those premiums and bears the
risk arising should the funds prove to be insufficient to meet the contractual
expectations may not be met over and above the guaranteed benefits under the
contract.

Law may not require certain types of plan to be funded for historical or
cultural reasons, e.g. traditional German book reserved plans 38, or in US
and Canada, benefits provided above certain tax thresholds. The tax system

38
The employer’s balance sheet needs to be strong enough, on given assumptions, to cover the balance sheet pension liability. Germany is unique in that it also provides a quasi-State
insolvency protection system on unfunded pension obligations (to a cap)
 22

also may not encourage funding.

For funded plans, deficits are recovered over time through (depending on Deficits in the sense of having insufficient assets to meet expected Benefit
local law) payments is simply not permitted in insurance. Rather if an insurer’s capital falls
 additional contributions from the employer below the level deemed prudent by the regulator, the insurer has to recapitalise in
 additional contributions from the employee a relatively short time through
 reduction in benefits 39  capital injections, and
 faster than expected future investment returns on plan assets  for participating contracts, reductions in constructive or discretionary
benefits where these can be enforced within policyholder protection rules
Typically, the greater the deficit, the faster the recovery period though pro-
cyclical rules can mitigate the strain on employers of increased funding in
difficult economic conditions (e.g recent US pension deficit recovery
measures). The recovery period can stretch over the future working lifetime
of the plan beneficiaries e.g. 10+ years.

Excess capital can only be returned to the employer in exceptional Within insurance regulations, excess capital can be returned to shareholders in
circumstances (if at all), typically only on dissolution of the trust after all lump sum form or paid over time through enhanced dividends.
benefits have been paid.

In some territorios and plan constructions, capital can never be returned to

the employer.

Unusual to have explicit margins above the liability measure (Netherlands Minimum capital requirements established by law to mitigate risk exposure to
is a notable exception, and some plans hold margins for admin expenses). policyholders
More usual to have implicit soft forms of capital such as
 Strength of the sponsor’s covenant and the ability to call for extra
Solvency contributions from the sponsor if the plan were to fall into deficit in the
margins future
 transparency of risk to interested parties through disclosure of fund
finances and operation to beneficiaries and regulators
 escrow accounts (harder form of capital)

39
Invariably accrued benefits are protected under local employment or pensions law though in extreme circumstances they may be reduced in some countries. Liabilities can also be reduced
by changing what were considered constructive obligations (e.g. stop plan to new accruals, salary linked on accrued benefits or beneficial early retirement terms for those who have not yet
reached eligibility for such terms) or discretionary obligations (e.g. non-guaranteed indexation of pensions in payment)
 23
An exception is for plans that bear biometric risks directly, ie no sponsor to
back up the fund. In Europe, for example, such plans adopt solvency
margins in line with those of an insurance company.
Rare, though some of the countries with the largest pension obligations in
absolute terms (US, UK, Germany, Switzerland, Ontario province in
Canada) operate quasi-State insolvency insurance arrangements that will
pay accrued benefits up to a capped level. Insolvency arrangements are
financed by mandatory annual premia payable by all funds. In the UK, the
premia are risk based.
Guarantee fund
in case of
insolvency
Being considered by some countries (e.g. Europe, Mexico) through new solvency
II type regulation currently in development.
Some countries provide for a compensation scheme operated at the level of the
insurance industry itself, e.g
 the UK Financial Service Compensation Scheme
 in Canada, a non-profit organisation called Assuris
 in Germany, a similar insurance industry arrangement called Protector.
 in India, policies sold by the State owned insurer are guaranteed by Law
 in Japan, the Life Insurance Policyholders Protection Corporation of
Japan applies
Typically, the insurers do not pay actual premiums to cover the risk that they will
collectively assume the obligations (to a cap) of one of their number defaulting on
its obligations. Rather costs are met when they fall due.
 24

Appendix Two – Examples of actuarial measurement approaches

The table below is taken from the UK Actuarial Profession’s 2010-11 research project on discount rates. It illustrates which actuarial approaches
in common use in UK actuarial work are matching and which budgeting in nature (in practice, elements of both approaches are seen in the areas
noted below). Similar results are anticipated if the exercise were repeated in other countries.

Key :
Pension approaches shown in red, Insurance in Blue, Government/Social Security in Green.

Matching Budgeting
• Accounting • Accounting
– Current IAS19 (pen) – Current (ins)
– Future IFRS4 (ins) – Director’s pensions
• Statutory reserves • Statutory reserves
– Future (Solvency II) – Current (ins)
• Capital requirements (ins) • Funding (pens)
– Current ICA – Technical provisions
– Future (Solvency II) – Deficit Recovery plans
• Shareholder (insurance) • Shareholder (ins)
– Market Consistent Enterprise Value – Traditional Enterprise Value
• Risk transfer • Risk transfer
– Section75 (Pen) – Transfer values (pen)
– Hedging (banks, ins) • Govt Social Time Preference Rate
• Fundamental value